“September seems to be an easy month for the market to misinterpret the Fed’s policy intentions.

The failure to announce a tapering of asset purchases in September 2013 prompted a wave of position liquidations and much anguish before a round of stronger data ultimately allowed the Fed to announce the start of tapering at its December meeting.

Now in 2015, the market has fully unwound the rally following the release of the September FOMC statement based on a combination of toughened Fed language, stronger risk markets and improved data in the US, China and also Europe.

Without a clear deterioration in US data, we think the market can gravitate towards pricing a 75-80% chance of Fed tightening in December from the current ~50%.

As clearest evidence of the new lease of life that has been given to the divergence trade, Exhibit 1 highlights the new cycle highs seen for USD EUR 2yr real spreads in the aftermath of the October FOMC.

We also note that the opening up of the downside for yields at the front end of the EUR curve has prompted a much stronger transmission of widening real yields spreads into EURUSD depreciation than seen since the first quarter of this year (Exhibit 2).”

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